Demand grows for emerging markets, bond ETFs

DavidFry

QUEENSTOWN, New Zealand -- Exchange-traded fund investors filled their portfolios with a mixed bag of market sectors and specialties during the first quarter.

Emerging-markets ETFs, for instance, gained broad investor interest. Since the re-emergence of bullish investor sentiment and activity beginning in 2003, investors have looked for opportunities in non-U.S. markets

Others sought shelter in more conservative investments. Bond ETFs were popular havens amid concern over terror, a weak U.S. dollar, budget and trade deficits, rising commodity prices, and political discord.

Popular investments included the iShares Lehman 20+ Year Treasury
TLT, -0.32%
and iShares Lehman TIPS
TIP, -0.06%
ETFs, for example.

Should downward trends persist, short-sale positions may be appropriate. Perhaps the market is just in correction mode and this downturn in the major averages will be seen as a buying opportunity. It's too soon to say. At the ETF Digest, we have maintained a cash position in most important equity ETFs since late February, successfully avoiding much of the quarter's market losses.

In addition, despite good performance in most technology sectors in 2003, confidence has faded. First, investors began unloading Semiconductor HOLDRs
SMH, -1.62%
while other tech sub-sectors performed reasonably well.

But, as I often told my subscribers this past quarter, "without SMH in the mix (higher), tech sectors are going nowhere."

The semiconductor sector continued to fade and dragged the entire tech sector south, with Software HOLDRs
SWH, +6.58%
falling rapidly.

Trend watching

During the bear market, many foreign investors sold U.S. stocks and, abetted by a weaker dollar, focused investments in a variety of global stock markets. This accounts for the better performance of many global stock indices versus their U.S. counterparts.

In the first quarter, the most popular emerging markets included Mexico, via iShares MSCI Mexico (Free) Index
EWW, -1.21%
and Malaysia, through the iShares MSCI Malaysia (Free) Index
EWM, -0.23%
Korea was another top draw, with a good showing from the iShares MSCI South Korea Index
EWY, -1.87%

By contrast, some first quarter "flat-liners" were early winners that fizzled in March.

Brazil and the iShares MSCI Brazil (Free) Index
EWZ, -0.92%
and Spain, with its iShares MSCI Spain Index
EWP, -0.49%
were two of the hottest markets early in the quarter.

The Brazilian ETF faded quickly due to that market's being much overbought, while Spanish stocks collapsed following terrorism and political upheaval.

Two popular and mainstream ETFs tracking the large-cap S&P 500 and the small-cap Russell 2000 also muscled into the start of the year, continuing the strength displayed during 2003's market rally. But their endurance waned as investors lost confidence in most U.S. growth-stock sectors.

Similarly, the first quarter of 2003 provided poor returns for most investors until U.S. stock-market sectors turned higher in April and finished the year with very strong results.

Rising interest

ETF demand has grown dramatically both due to the now widely discussed inherent benefits of the product and the mutual-fund trading scandal.

Mutual fund companies -- notably giants Vanguard Group and Fidelity Investments -- are stepping up activities in issuance of ETF-based product. Barclays Global Investors continues to provide new offerings for its iShares brand, while investment-research firm Morningstar is enhancing its ETF coverage.

In the second quarter, expect to see new ETFs issued in important market sectors, including gold. Mutual funds will have greater opportunities to utilize the ETF medium more for issuance of non-indexed funds as investor interest remains strong and traditional distribution outlets change. ETFs that track a U.S.-dollar index or a commodity index would be extraordinarily popular.

One thing is for sure, Wall Street ETF product engineers will be busy creating new ETF products and others to evaluate and utilize as investment vehicles. Some of these ETFs are much needed, while others will be either redundant to existing products or ill conceived.

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